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Q d always responds positively to the change in income.

Q d always responds positively to the change in income. Less Elastic. Y. More Elastic. Q d. O. ∆ Y in PQ space. P. Elastic D D``. D``. D`. Inelastic D D`. D. Q. Example. Rule: If sign is positive the good is normal and if sign is negative

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Q d always responds positively to the change in income.

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  1. Qd always responds positively to the change in income. Less Elastic Y More Elastic Qd O

  2. ∆ Y in PQ space P Elastic D D`` D`` D` Inelastic D D` D Q

  3. Example Rule:If sign is positive the good is normal and if sign is negative the good is inferior. YЄd = ∆ Q÷∆ Y Q Y = 5 ÷ 2000 100 10000 = 0.25 The Good s normal (the sign is positive). But its demand is income inelastic o< | Є | < 1.

  4. Determinants of income elasticity of demand 1. Degree of necessity of good. 2. The rate at which the desire for good is satisfied as consumption increases 3. The level of income of consumer.

  5. Cross price elasticity of demand It is defined as the percentage change in quantity demanded of good A divided by the percentage change in the price of another related good B.

  6. Example Rule:If a sign is positive the goods are substitutes and if a sign is negative the goods are complements PbЄda= ∆ Qa÷∆ Pb Q a Pb = 40 ÷ 2 100 10 = 2 Goods are substitutes ( sign is positive ) Demand is cross price elastic | є | > 1.

  7. Example 2 • A Government will wish to know how a change in • domestic prices will affect the demand for imports. • Rise in price of imports worsening the Balance of • payments

  8. Adjusting to oil price shocks SHORT RUN P S2 S1 B P2 A P1 D1 Q O Q2 Q1

  9. Adjusting to oil price shocks Long Run effect on demand P S2 S1 B P2 A C DL P1 D1 D2 Q O

  10. Adjusting to oil price shocks Long Run effect on supply P S2 S3 S1 B P2 SL F E P1 D D1 Q O

  11. Incidence of tax when the demand is inelastic • Fixed Tax P S2 C S1 T A X P1 D B P0 D X A D Q Q1 Q0

  12. Incidence of tax when the demand is elastic • Fixed Tax S1 P S0 T A X C` P1 B` D` P0 D X` A` Q O Q1 Q0

  13. Inelastic demand • Case 1 S + Tax P T A X S1 P2 P1 D Q O Q2 Q1

  14. Elastic demand • Case 2 S + Tax P T A X S1 P2 P1 D Q O Q2 Q1

  15. Inelastic supply • Case 3 S + Tax S P T A X P2 P1 D Q O Q2 Q1

  16. Elastic supply • Case 4 P S + Tax T A X P2 S P1 D Q O Q2 Q1

  17. Tax on smoking • Case 1 S + Tax P T A X S1 P2 P1 D Q O Q2 Q1

  18. Tax on environmental pollution • Case 3 S + Tax S P T A X P2 P1 D Q O Q2 Q1

  19. Summary 3 Core rules of elasticity RULE # 1: Less than Greater than Inelastic Elastic 1 RULE # 2: Normal good + Income elasticity – Inferior good RULE # 3: Substitutes + Cross elasticity – Complements

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